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29 September, 07:54

14. The real risk-free rate of interest is 2%. Inflation is expected to be 3.5% the next 2 years and 6% during the next 3 years after that. Assume that the maturity risk premium is zero. What is the yield on 3-year Treasury securities? What is the yield on 5-year Treasury securities?

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  1. 29 September, 10:59
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    3-year = 6.33%

    5-year = 7%

    Explanation:

    Yield in security = Risk free rate + Maturity risk premium + Inflation premium + Liquidity premium + Default risk premium

    Maturity risk premium is given as 0

    Yield on 3-year treasury securities is 2 + [ (3.5 + 3.5 + 6) / 3] + 0

    = 6.33%

    Yield on 5-year treasury securities is 2 + [ (3.5 + 3.5 + 6 + 6 + 6) / 5] + 0

    =7%
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